Three Remaining Tenant Allowance Issues – A Wrap-up

Here’s the wrap-up! We started the Tenant Allowance series on November 21 with seven questions and when posted Part 2 on December 4, we were left with three: (5) should the landlord get any part of the (Tenant Allowance) money back if the lease is prematurely terminated; (6) what happens if the landlord doesn’t pay the allowance; and (7) should the lender pay the allowance if it takes the property over before the money is paid? My answers: (5) yes: (6) offset; and (7) yes.

If I stop here, that would the shortest posting yet. So, I won’t.

Back in Part 1, I offered my view that Tenant Allowance monies are built into the rent – call it a ‘loan component.” If there were no Tenant Allowance, the rent would be lower. That’s because when a landlord pays a Tenant Allowance, the landlord is renting more than “space,” it is also renting money. The incremental rent to “recapture” the Tenant Allowance is spread over the initial term of the lease. A lot of tenants don’t pay attention to this “fact” or just don’t care, because it is fairly common for the “increment” to continue into renewal periods even though no new money will be advanced at the time of their lease renewal. Others are quite savvy and do care. In those cases, the renewal rents are negotiated with the knowledge that the rent for the initial term was “jacked up” to cover the Tenant Allowance. In a much smaller number of cases, a landlord actually advances more Tenant Allowance at renewal time, most often in the case of restaurants where remodeling is common at renewal time.

So, what is the corollary of what I just wrote? Answer – if the lease ends before the initial term was intended to end, and the reason was other than something the landlord shouldn’t have done, the landlord should get back the present value of that part of the Tenant Allowance that hasn’t been “repaid.” This isn’t the place to show any calculations, especially because most landlords and tenants agree on the “enhanced” rent by gut feel, not formula. But, basically, landlords will be looking for the total remaining incremental rent or perhaps, more simply expressed – if the lease ended half way through the initial term, a landlord will be looking for half of the Tenant Allowance back.

Sometimes, landlords just don’t pay the Tenant Allowance when due. There are a myriad of reasons this can happen, but a tenant isn’t interested in collecting “reasons,” it is interested in collecting the Tenant Allowance. And it isn’t interested in just having the rent drop by a dollar or two a square foot, just as if the rent were set without the tenant taking a Tenant Allowance. Tenants want the money real fast, and they don’t want to chase the landlord. So, what they do is something akin to a “garnishment,” they intercept payments that would otherwise be going to the landlord. The easiest of those payments to intercept is the very rent the tenant, itself, is paying. And, that’s done by way of offset. How much, how fast? If there were no other issues, that would be easy to answer – as fast as can be, certainly with interest accruing from the day the Tenant Allowance payment was first due.

Now, offset can be tricky. Landlords cry out – “our lender won’t allow it.” That’s just not true. Lenders approve leases with offset provisions all the time. They just want to make sure there is enough cash flow to comfortably cover the mortgage. That means if the lease is a key part of the property’s income, there is going to be some limit on how much can be held from the monthly rent. A good starting point is to consider that a loan calculated on 75% of the rent flow should easily permit offset of up to 25% of a tenant’s rent. For the common multi-tenant project, a limit of 50% is quite common because cutting most tenant’s rent in half until the Tenant Allowance is recaptured reduces the project’s monthly rent collection by far less than 50% or 25%. That logic can often justify offsets without limit, but at some point emotion and irrational fear takes over in negotiations.

Now, why would I dare suggest that a lender should pay the agreed-upon Tenant Allowance if it should happen to take over a project before the allowance has been paid? Well – for the same reason as posited at the beginning of this posting. The Tenant Allowance is being paid back in the form of increased rent. If the lender wants to receive the stated rent, a part of which is “paying back” the Tenant Allowance, then the Tenant Allowance has to have been paid in the first place. Lenders shouldn’t get something (the higher rent) for nothing (which is what would happen if the Tenant didn’t get the Tenant Allowance). This doesn’t necessarily mean that a lender has to write a check for the Tenant Allowance to the tenant, but if the allowance wasn’t paid, it should be accepting the tenant’s offset.

I know there are many attorneys and other lease negotiators out there who have been trained to say: NO OFFSET; and, NO, the lender won’t accept an offset, let alone pay the delinquent Tenant Allowance. So, if anyone is going to say those things in reaction to this posting, please explain why you think that way. Ruminations awaits your comments at www.retailrealestatelaw.com.

Ira, Here in Canada, if the lease terminates due to a tenant’s default, then the landlord is entitled to damages for the loss of future rent (net of mitigation rent, discounted to present value, etc.) such that, in theory, the landlord is made whole for the loss of rent for the balance of the term. In such a case, requiring repayment of all or a pro-rated part of the tenant improvement allowance (which, as you acknowledge, is built into the rent rate) would be double recovery for the landlord. At least, that’s what I argue when acting for tenants.

No Offsets. The reason is the same as any default of lease terms. There should be notice, and cure. If not cured, then landlord defaults and the tenant pursues action. If there is an offset, the tenant has an unfair advantage over the landlord to solve a problem that may only exist in the eyes of the tenant. Also, Landlord may not be able to account for offset rents in the same manor it would cash allowances. In my view, Rent is “sacred” and should always be seperate from any dispute.

Disclaimer: Ruminating and rambling can easily be confused. There are a lot of dictionary meanings for “ruminating.” Our favorite (today) is: “to turn a matter over and over in the mind.” That sounds a lot like “rambling.”
For that reason, no one should mistake anything written on this blog as resembling legal advice, even when written by an attorney —not the original blog entries, and not any comments. This blog is intended to be a discussion board for concepts–some flakey, some not–that affect Retail Real Estate Law. Please join that discussion.